A few weeks ago, when discussing my Bearish 2nd half outlook, a guest on Kudlow said "That could only happen of the dollar really gets killed." I answered that a dollar collapse was only one risk factor facing markets at this phase; clearly, its an important issue for how markets will perform.

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Today, the WSJ reports "The dollar is suffering its most painful selloff in months, a trend that could reverberate throughout the stock and bond markets."

As Oil spiked and Gold rallied (or is it the other way around?) U.S. currency fell to an 11-month low versus the euro Friday. Its also at a two-decade low against the Canadian dollar. Last week’s drop was the biggest decline in 4 months.

History reveals that as soon a sthe Fed stops, equity Markets rally a few percent, while the dollar sells off hard. The Pause/Resume scenario Bernanke hinted at last week is certainly a motivating force for last week’s dollar daze.

Analysts say the biggest beneficiaries of further dollar declines this year are likely to be the yen and other Asian currencies, some of which have been rallying since the fall. The Korean won, for instance, has soared 11% against the dollar over the past six months and is back to levels not seen since the 1997 currency crisis. The yen rose to 113.86 yen last week versus the dollar, a six-month high.

The dollar already was going through a rough patch when it was hit on two fronts last week. The Group of Seven leading industrial nations said emerging economies should let their currencies appreciate to help reduce the large trade surpluses these countries have with the U.S. and other developed nations. Analysts say the G-7 statement represents a step forward from Washington’s lone voice and ratchets up the pressure on Asian governments to allow their currencies to appreciate.

Federal Reserve Chairman Ben Bernanke, testifying before Congress on Thursday, offered the strongest indications yet that the central bank might be about to pause after a long period of interest-rate increases. For traders already inclined to sell the dollar, "this was like waving a red flag in front of a bull," says Adnan Akant, a managing director at New York money manager Fischer Francis Trees & Watts.

A falling dollar could mean bad news for the bond market because it can lead to inflation and higher interest rates. While a weaker currency is beneficial for some stocks because it makes their products overseas more competitive, many companies also would face higher costs on goods from abroad."

Things to watch for are weakening consumer staples (Wal-Mart), slowing foreign capital flows into US investments, a new challenge for Asian exporters (Sony, Toyota). Its a negative for Bonds, as a weak currency is inflationary, and yield will have to rise proportionately to attract overseas investors and make up for thier currency risk. I would expect banks to be problematic also.

On the strong side: Material and energy sectors (Oil & Gold) US exporters and industrial manufacturers (Boeing, General Electric, Caterpillar and John Deere), Tourism and Travel to the US gets that much more attractive to Europeans and Asians.